Spain sank into recession in the first quarter and economists said spending cuts aimed at meeting strict EU deficit limits, together with a reeling bank sector, would delay any return to growth until late this year or beyond.
It is the second recession in just over two years for the euro zone’s fourth largest economy and comes as the government tries to convince investors it will not need outside aid to put its house in order.
The country is caught between pressure from its European peers to fix public finances and growing domestic resistance to austerity measures that have helped push unemployment to more than double the EU average.
Ratings agency Standard & Poor’s added to the country’s problems with a two-notch rating downgrade last week and on Monday it chopped the credit score of 11 banks.
While the 0.3 per cent contraction from January to March from the previous quarter was slightly better than the forecast drop of 0.4 per cent, it confirmed the economy is deteriorating.
“The wheels are very clearly coming off,” Jefferies economist David Owen said. “It wouldn’t surprise me to see a very significant decline in GDP both in the second and third quarters this year.”
Spain was last in recession, defined by two consecutive quarters of contraction, at the end of 2009.
The government’s latest economic plan, published on Friday before it was sent to the European Commission for approval, forecast a contraction of 1.7 per cent in 2012 turning to meagre 0.2 per cent growth by next year.
Spain’s demand for electricity, a good indicator of the strength of economic output, fell for the eighth month in a row in April, the national grid operator said.
Spanish bonds showed little reaction to the GDP report but yields have risen to around 6 per cent in recent weeks. At around 7 per cent, they are seen as financially unsustainable.
The IBEX share index finished April down 12.7 per cent, its worst monthly showing in nearly 1-1/2 years..
The S&P downgrades of both Spain and its banks put the country’s fragile financial sector back into the spotlight, while an unemployment rate nearing 25 per cent will remain a drag on already tight public accounts.
“Did you need any more reasons to short Spanish debt?” the 4Cast consultancy said in a research note on Monday.
The banks were damaged by a real estate collapse that began in 2008 and now bad loans in other sectors of the economy have risen sharply.
With virtually no access to wholesale funding markets, the banks have taken on a large amount of cheap European Central Bank money and bought domestic debt, helping the Treasury to fulfill half of its gross issuance already this year, an achievement that gives Madrid some room for manoeuvre.
ECB data on Monday showed Spanish and Italian banks filled their coffers with government bonds again last month, confirming that they had helped keep a lid on yields.
But non-residents, which before December held an average of around 50 per cent of Spain’s debt, had just 37.5 percent in March, the Treasury said.
The country’s two largest banks Santander and BBVA have suggested they may not buy any more government bonds this year, adding to fears the Treasury may have to pay higher costs to place new debt.
Some investors have been betting the ECB will restart its program of buying bonds of troubled euro zone states but some of its policymakers are fiercely opposed to the idea.
Spain’s regions, also in sharp focus after they were blamed for most of 2011’s fiscal slippage, have been told to cut their own deficits or face central government intervention.
None of the 17 autonomous regions would require central government help to slash costs, a Finance Ministry source said. Regional authorities must pass their plans for reducing their deficits to Madrid by the end of Monday. The government will then have two weeks to approve the plan.
Economy Minister Luis de Guindos said on Monday Spain would announce plans to privatize parts of the public transport sector as part of its strategy to reduce the deficit.
Alongside pressure from Europe for measures to stabilize the budget, there is resistance to the austerity measures needed to achieve this. Thousands of Spaniards took part in protests on Sunday.
There is growing opposition around Europe to the bitter medicine prescribed by policymakers from European institutions and from fiscally conservative countries such as Germany.
Economists, including some from the International Monetary Fund, have started to question whether it is right to push austerity at the expense of restarting growth.
“I assume we get some policy response out of the ECB and Spain is allowed to rein back on its fiscal austerity it is pushing through. There’s certainly a lot of push back as people question the German-centric view of the world that everyone needs more austerity,” said Mr. Owen.
Talk of growth stimulation in Europe does not exclude the need for austerity, German Finance Minister Wolfgang Schaeuble said on Monday during a conference in northern Spain.
“Not only do we need fiscal consolidation but we need it for something, to generate sustainable growth, which is the best way to generate employment,” he said.
The Spanish government has announced savings of over €40-billion ($53.04-billion U.S.) this year from both central and regional government budgets, to try and cut the deficit to 5.3 per cent of GDP from 8.5 per cent of GDP in 2011.
Economy Minister de Guindos announced the transport privatization plan at the same conference as Mr. Schaeuble, but gave no details.
The conservative government, which took power from the Socialists in December, has told the banks to raise over €52-billion in capital this year.
However, with property prices expected by some to fall another 20-30 per cent, many economists believe increased banking provisions against potential bad real estate loans will not be enough to stabilize the sector.
Some economists say the country will eventually need a financial bailout package like Greece and Ireland but the government has repeatedly said it will not seek outside help.